What is the psychological aspect of trading?
The psychology of trading is complex and it takes time and commitment to fully master. It is a broad term that includes all the emotions and feelings that a trader will experience while trading. Some of these emotions are positive and helpful which should be embraced while other ones like fear, greed, nervousness and anxiety should be banished. The mental aspect of trading is often overlooked but it is a foundational part of any trader’s skill set. For a more in-depth coverage of this subject, click here
Why is the psychological aspect of trading important?
The psychological aspect of trading is a difficult barrier to control. It is not something we are born with, it is something to be developed. It requires discipline, patience, acceptance, and resilience. Foreign exchange trading is very stressful. Stress and pressure lead to mistakes. Mistakes lead to losses. If you can manage your emotions, you will avoid pitfalls. You will learn to deal with difficult situations and grow to become a consistently profitable trader.
What are the basics of trading psychology?
Trading Psychology is the emotional extension of the trader’s decision making process related to market dynamics and of the trader’s sentiment defined by greed and fear.
Trader’s sentiment is formed by past experiences and by the actual impact of the latest news and conditions.
The real challenge is in reducing the impact of the built in emotions fueled by failure or success while assessing the behavior of the markets.
Some traders are more apt to trade based on emotions and risk the outcome by questioning their wisdom and by not following their plan, which may force them to close their positions too early or to hold a losing position too long. It is after-all a mind game.
What are the common emotional traps?
It is very important to identify the emotional impulses that can derail our mind, we need to understand how and why emotions manifest in our trading.
It will help to analyze past trades (regularly) and try to understand what caused the loss. You will often find out that the same triggers and impulses were the root causes. Tracking the past patterns should help in catching yourself sooner and sooner whenever the same impulses come back.
Fear-Is one of the two most frequently talked about emotions in trading. Fear manifests itself in a number of ways in trading and it can be the cause of many trading mistakes.
The fear of losing lets traders delay the realization of a loss, which then turns into much greater losses, and the fear of giving back profits which make traders close winning trades too early.
Greed- When we look at the hard facts, greed often causes a number of impulsive trading decisions that should be avoided. Traders who are influenced by greed often don’t adhere to sound risk and money management principles. Greed also reinforces the gambling mindset which describes trading without set rules and based on impulsive decisions.
Hope- Fear and greed come hand in hand. Traders who are in a losing position generally show signs of hope , when they fail to accept the upcoming loss and give a trade more room to breathe. There are other instances where traders try to compensate (hope) for past losses by entering a trade with a position that is too big and not according to their plans/rules.
Excitement/Anxious- Any feelings over excitement while trading means that as some point, somewhere a mistake has been made. When the trader is overly anxious during a trade, it is a sign that the position may be too big, rules have been broken or that maybe the trader shouldn't be in that trade.
Boredom- Is more a current state than an emotion. Traders who are bored usually lack focus. The trader lacks focus when they go through the same instruments and time-frames over and over without clearly knowing what they are looking for or when they miss trade entries, because they weren't paying attention or they were browsing the internet and doing something other than trading. It is time to take a break.
Frustration- Is oftentimes the source of errors that result from the previously mentioned emotional conditions. Frustration begins to show when traders miss trades, because they do not follow the trading plan, breach their rules and lose money, take too much risk and lose large amounts of money, or recognize after the fact what they should have done. Frustration then reinforces all the bad negative behavior patterns that a trader is challenged with and intensifies the trader's emotions/problems.
The moment you find yourself with the following thoughts is time to take a break and refocus.
“I missed the trade, I did everything as planned.” “I should not have risked as much on this trade.” “It looked so good." ''I think it’s going to turn around. I just increased my stop loss order a bit.” “It was a prime good setup. It was on point.” ''The trade looked so good. I thought it would move further and not turn around that quickly." ''The trade has already made some good profits. Maybe I should shut the trade down before it turns around.” “It is not the best trade, but I’m willing to give it a go.'' “I exited too early and should have let it run – next time I will set my take profit further away.” “I knew it! I knew it was going to go that direction.”
Step back and consider the following:
- Analyze trades that you have taken and missed and evaluate whether some of your entry criteria kept you out of profitable trades. Go back and simulate and make a list of things to be worked on.
- Don't be upset if you have followed your plan/rules, but noticed that a trade would have moved further, or entering a trade early would have been a better decision and made you more money. Instead, congratulate yourself for following your trading plan – religiously following your trading plan is a foundational and a key attribute of a professional trader.
- Do not let the outcome of a single trade affect your trading decisions on your future trades. Have a marathon mindset not a sprinter’s. This is a journey, not a short trip.
- Think big! Collect hindsight-data and only alternate your trading strategy after you have a big enough sample size that will provide you with statistically meaningful information. Trust the process.
Tips & Tricks To Control The Mind
Many problems with trading emotions are caused by an external definition of what "success" means to us. Each trader must define our success as traders based on our own definitions, not on the definitions of others. Before you are a trader, you are a human being with many responsibilities. Family, work, friends, bosses, significant others and many other responsibilities and the pressures that come with them. What is in your mind before you begin trading? It is important to begin the trading in a good frame of mind. Stop taking loses personally as a way to end the strong influence of negative emotions that hurt your trading results. Accept the randomness of the markets. It will help in executing your trading strategy regardless of the emotions you feel. Analyze the causes of your emotions. It is trade related or did you begin our day with altered emotions?
Understanding your trading mistakes.
Is it caused by your learning curve caused by weakness in your experience level or tactical decision making? Is it a mistake caused by not following the game plan? Is it a mistake caused by a weakness in the mental game?
Build on your strengths to control trading emotions. Many trading pitfalls can be avoided by focusing on strengths instead of weaknesses. It is very common for trades to only focus on the mistakes they are making instead of focusing on things they do well and succeed. Master your trading. Trade the plan. Professional traders use plans, while individual traders may trade with intuition, this will lead to trading impulsively and making costly mistakes.